European stocks slipped from an 11 month high, Asian stocks and S&P futures were flat as caution pervades global markets before the Federal Reserve’s expected interest-rate hike on Wednesday. Crude dropped to session lows near $52 after API data showed U.S. stockpiles increased, and after a Manaar Group consultant said Iraq won’t cut output by 180k b/d-220k b/d as it committed to do under Nov. 30 OPEC agreement. 

Top corporate news stories include Johnson & Johnson ending Actelion pursuit, IBM vowing to add 25,000 jobs, Hertz replacing its CEO, the WSJ reporting that Goldman is planning to appoint Harvey Schwartz and David Solomon to succeed President Gary Cohn.

“Markets are very much on hold ahead of the Fed,” said Marc Ostwald, strategist at ADM Investor Services International in London told Bloomberg. “The Treasury rally is also helping to pull yields elsewhere lower, along with a slip in oil prices and a softer tone to equities. Changes to the Fed dot plot and economic forecasts will be key to watch.”

Today’s FOMC decision has been overshadowed by some big events over recent weeks. As DB’s Jim Reid writes in his overnight piece, today’s outcome has barely registered on people’s radar as a potential macro event. Consensus is the expected 25bp hike but with a wait and see approach from Yellen where she’ll reiterate that it’s too early to second guess potential upcoming fiscal changes. A December rate hike is now fully priced in by the market.

However DB’s Peter Hooper does think that the overall message will be modestly hawkish given the shift in risks toward higher growth and inflation ahead. The more hawkish signs should come from a mention of the decline in unemployment and further increase in market based measures of inflation compensation while near term risks should now be noted as fully balanced rather than roughly balanced. The interesting and more uncertain element will be how they treat forward guidance. DB thinks that it’s quite possible that they add ‘changes in fiscal policy’ to the list of factors that will determine ‘the timing and size of future adjustments to the funds rate’. More important is whether they decide to change expectations of ‘gradual’ increases in the fed funds rate and rates remaining ‘for some time’ below levels expected to prevail in the long run.

The economic projections and the dots are clearly the other big focus. Consensus expects only modest upward revisions to growth and possibly inflation forecasts, and unemployment to be revised down. In terms of the dots, Peter highlights that while it will take only two dots moving up to raise the median from two to three rate increases next year, he does not expect the Committee leadership to change their view significantly just yet. He notes that they will need to see more about how events unfold with the new Administration and the new Congress before making appreciable changes.

The Fed’s path to tighter monetary policy has been delayed throughout 2016, as first instability in Chinese markets, then the shock votes for Brexit and Donald Trump, put policy makers on the defensive. The U.S. central bank is expected to boost borrowing costs just as the focus shifts back to governments, with fiscal easing at the hands of incoming U.S. President Trump speculated to drive economic growth. After Wednesday, traders see a two-in-three chance of additional rate increases from the Fed by June, futures show.

“Last year the Fed guided the markets to expect at least four rate rises this year, guidance that proved to be woefully wide off the mark, and it is likely that they won’t want to make the same mistake again,” Michael Hewson, chief market analyst at CMC, wrote in note. That “suggests that Fed chief Janet Yellen can expect some serious cross examination of how the FOMC view not only the economy, but also President-elect Donald Trump’s plans for it.”

To be sure, not even the Fed really knows how to approach 2017, a year in which Trump’s Fiscal stimulus is expected to play a greater role than monetary policy, which has been dominant in the past 7 years, so expect another year of dot-plot driven confusion.

An additional consideration this year is how Trump may respond to the Fed announcement, and whether he will tweet his reaction in response to the Fed announcement. As Bloomberg put it, “if you’re looking for drama surrounding this week’s meeting of Federal Reserve officials, don’t look for it in their post-meeting statement. Policy makers are almost universally expected to raise their benchmark lending rate. Keep an eye, instead, on President-elect Donald Trump’s Twitter feed.”

He was a harsh critic of Fed Chair Janet Yellen during the election campaign, and how the nation’s incoming chief executive reacts to the expected hike on Wednesday may reveal much about whether and to what extent Trump will try to pressure the central bank through the remainder of her current term, which expires in February 2018.

Investors have already pushed up bond yields since Trump’s surprise Nov. 8 election win in anticipation of higher inflation. They are likely to take note of any White House bullying of the Fed, which is expected to continue raising rates next year, albeit at a very gradual pace.

“It’s an important thing to keep an eye on,” said Donald Kohn, a former Fed vice chair who is now a senior fellow at the Brookings Institution in Washington. “It helps policy making, and the public perception of policy making, if the administration is not publicly commenting. It reinforces the idea of a monetary authority independent from short-term political pressure. Eroding that would be moving in the wrong direction.”

So keep a close eye on what Trump tweets after 2:00 pm ET, a moot notice considering how much single-name volatility Trump’s tweets have generated in recent weeks.

The Stoxx Europe 600 Index retreated before the conclusion of the Fed’s two-day meeting, as investors awaited clues on the likely path of rates in 2017. Yields on 10-year U.S. Treasuries slipped, after reaching the highest level in more than two years on Monday, while European bonds also climbed. Oil in New York slid to near $52 a barrel before an official inventories report, and currencies of commodity-exporting nations fell. Gold headed for its biggest gain in a week.

Europe’s Stoxx 50 Index declined 0.6% after the gauge surged more than 20 percent from its low in February, entering a so-called bull market on Tuesday. The Stoxx 600 Index fell 0.4 percent as of 10:24 a.m. in London.

• Actelion Ltd. dropped 8.4 percent after Johnson & Johnson said it ended discussions for a potential deal.
• Mediaset SpA added 5.8 percent, following its biggest gain in 20 years on Monday, as Vincent Bollore’s Vivendi SA and Silvio Berlusconi’s Fininvest SpA battled for control of the Italian broadcaster.
• Metro AG gained 4.7 percent after the German retailer forecast a rise in sales and earnings for the full year.

S&P500 index futures dropped 0.1% after the S&P 500 Index rose 0.7% to an all-time high and the Dow Jones Industrial Average neared 20,000 points.

In rates, the yield on 10-year Treasuries fell three basis points to 2.44 percent, after touching 2.53 percent on Dec. 12. The yield on similar-maturity German bonds dropped three basis points to 0.33 percent, while Italy’s fell five basis points to 1.82 percent. Japan’s 30-year government bonds climbed as the nation’s central bank stepped up purchases of longer-term debt. The Markit iTraxx Europe Crossover Index of credit-default swaps declined one basis point to 294 basis points, the lowest since April. The investment-grade Markit iTraxx Europe Index was little changed after falling for 11 days, the longest stretch in more than nine years.

Market Snapshot

• S&P 500 futures down less than 0.1% to 2267
• Stoxx 600 down 0.5% to 356
• FTSE 100 down 0.3% to 6950
• DAX down 0.3% to 11251
• German 10Yr yield down 2bps to 0.34%
• Italian 10Yr yield down 5bps to 1.82%
• Spanish 10Yr yield down 1bp to 1.42%
• S&P GSCI Index down 0.6% to 394.4
• MSCI Asia Pacific up less than 0.1% to 139
• Nikkei 225 up less than 0.1% to 19254
• Hang Seng up less than 0.1% to 22457
• Shanghai Composite down 0.5% to 3141
• S&P/ASX 200 up 0.7% to 5585
• US 10-yr yield down 3bps to 2.45%
• Dollar Index down 0.09% to 100.98
• WTI Crude futures down 1.1% to $52.41
• Brent Futures down 1% to $55.16
• Gold spot up 0.3% to $1,161
• Silver spot up 1% to $17.08

Top Global News

• J&J Ends Deal Talks With Actelion in Potential Boost for Sanofi: Swiss biotech says it’s in discussions with another company
• Hertz Global Replaces CEO After Earnings Misses, Stock Slump: Former airline executive leaves after 2 disappointing years
• Goldman to Name Solomon, Schwartz to Succeed Cohn, WSJ Reports: Chavez likely to replace Schwartz as CFO, newspaper says
• Fox Said to Stick With Initial Price for Now in Sky Bid: Murdochs said to not rule out raising offer to help seal deal, official offer expected to be announced as soon as Thursday
• Wells Fargo Faces Limits After Second Living Will Failure: Company kept from growing its non-bank activity, agencies say
• GM China Venture Said to Be Under Government Anti-Trust Probe: GM trails only VW among foreign automakers in China sales
• China Said to Lift Tax on Smaller Cars to 7.5% Through 2017: Tax was halved to 5% from 10% in October 2015 to spur demand
• Morgan Stanley Group Offers $5.5 Billion for Lotteries Giant: Bid for Australia’s Tatts valued at up to A$5 a share
• Newmont Sees Up to $1.2 Billion Writedown on Peruvian Mine: Charge probably will be booked in fourth quarter, company says
• Oil Retreats After OPEC Deal Rally on Reported U.S. Supply Gain: U.S. crude inventories increase by 4.68 million last week, API says
• Disney Said to Ask Other Studios to Join Digital Movie Service: Studio’s Movies Anywhere lets users access films bought online
• AMD Says Zen, Chip That Must Win, Ready to Compete With Intel: New desktop PC processor to debut in first quarter of 2017
• SkyWest to Take Charge of Up to $490 Million in Fleet Shift: Regional airline removes some of the industry’s smallest passenger jets from service

Asia equity markets traded mostly higher following another record day in the US, where all major indices printed fresh all-time highs and DJIA advanced to within 100 points from the 20,000 level. ASX 200 (+0.7%) took the impetus from US with outperformance in consumer discretionary as Tatts Group shares gained around 9% after a consortium launched a competing bid for the firm. Elsewhere, Nikkei 225 (Unch.) was indecisive amid a firmer JPY and after a somewhat disappointing BoJ Tankan survey, while the Shanghai Comp (-0.5%) was choppy as participants counterbalanced rising money market rate concerns with the PBoC finally boosting its liquidity injection. Furthermore, the Hang Seng (+0.2%) gained with Sinopec among the leaders following reports it is to sell a 50% stake in a major pipeline for USD 3.3bIn.

Top Asia News

• Copper Supply From Top World Mine Threatened as Export Ban Looms: Indonesian government’s ban on overseas concentrate shipments is scheduled to come into force from the middle of January
• Billionaire Shi Boosts Investment in China’s Minsheng Bank: Now has stake, including derivatives, equivalent to 9.6% of Minsheng Bank’s currently issued Hong Kong stock
• China Credit Expands Most Since March on Robust Mortgage Lending: Aggregate financing rose to 1.74 trillion yuan in November
• China Economy Defies Prophets of Doom as 2017 Risks Loom: Industrial output and fixed-asset investment maintained brisk expansions in November and retail sales accelerated, data released Tuesday showed
• Sinopec Said to Revive Up to $10 Billion IPO of Retail Unit: Has asked banks to submit proposals by this month for roles to manage potential Hong Kong listing next year

European equities trade with marginal losses as participants await the FOMC rate decision in which the US central bank is expected to hike the Federal Fund Rate by 25bps (Full preview in the research section). In terms of notable movers of the morning, Actelion shares plunged 8% after Johnson & Johnson withdrew their takeover bid. Elsewhere, the troubled Italian lender Monti Paschi hit limit down amid reports that the ECB rejected request for more time to raise capital. In fixed income markets, the pull back in yields continues, while peripheral bonds yet again outperform with the Italian 10yr yield falling to 1-month lows after Italy’s interim PM won a vote of confidence, in turn the Italian-German 10yr spread has narrowed to 148bps. Additionally, overnight JGB yields outperformed in the long-end after the BoJ increased bond purchases to curb rising yields.

Top European News

• U.K. Employment Declines for First Time in More Than a Year: Jobless rate remains at 4.8%, statistics office data show
• Inditex Sales Growth Accelerates on Zara’s Online Expansion: Retailer posts fastest start to a quarter in more than a year
• Moguls’ Feud Puts Berlusconi’s Italian Media Empire in Play: Billionaire Bollore’s Vivendi builds 12% stake in Mediaset

In currencies, the Bloomberg Dollar Spot Index, a gauge of the greenback against 10 major peers, was little changed after rising 0.1 percent on Tuesday. Traders say the dollar should have a muted reaction to the Fed’s expected 25 basis-point hike, but may see more volatile price action in reaction to Chair Janet Yellen’s subsequent press conference. Russia’s ruble fell 0.3 percent against the dollar, and Norway’s krone declined 0.2 percent

In commodities, West Texas Intermediate crude retreated for the first day in five, falling 1.2 percent to $52.37 a barrel. Crude is retreating as focus shifts to expanding U.S. crude stockpiles. U.S. inventories rose by 4.68 million barrels last week, the industry-funded American Petroleum Institute was said to report. Government data Wednesday is forecast to show supplies fell. Gold added 0.3 percent to $1,161.45 an ounce in the spot market. Zinc led a rally in most industrial metals, climbing 1 percent to $2,732 a metric ton on the London Metal Exchange, after a data showed credit in top consumer China expanded the most since March.

DB’s Jim Reid concludes the overnight wrap

As we count down to Xmas, today’s FOMC decision has been overshadowed by some big events over recent weeks. Indeed in all my many 2017 outlook meetings today’s outcome has barely registered on people’s radar as a potential macro event. It seems the consensus is the expected 25bp hike but with a wait and see approach from Yellen where she’ll reiterate that it’s too early to second guess potential upcoming fiscal changes. However DB’s Peter Hooper does think that the overall message will be modestly hawkish given the shift in risks toward higher growth and inflation ahead. The more hawkish signs should come from a mention of the decline in unemployment and further increase in market based measures of inflation compensation while near term risks should now be noted as fully balanced rather than roughly balanced. The interesting and more uncertain element will be how they treat forward guidance. Peter thinks that it’s quite possible that they add ‘changes in fiscal policy’ to the list of factors that will determine ‘the timing and size of future adjustments to the funds rate’. More important is whether they decide to change expectations of ‘gradual’ increases in the fed funds rate and rates remaining ‘for some time’ below levels expected to prevail in the long run.

The economic projections and the dots are clearly the other big focus. Peter expects only modest upward revisions to growth and possibly inflation forecasts, and unemployment to be revised down. In terms of the dots, Peter highlights that while it will take only two dots moving up to raise the median from two to three rate increases next year, he does not expect the Committee leadership to change their view significantly just yet. He notes that they will need to see more about how events unfold with the new Administration and the new Congress before making appreciable changes.

All that to look forward to later this evening. In the mean time one of the events which has overshadowed the Fed for now is the twist and turns in the Italian banking sector saga. The sector got a big boost yesterday however after Italy’s largest lender, UniCredit, announced a bumper €13bn rights offer to shore up its balance sheet. In conjunction, the bank also announced a host of restructuring, cost cutting measures and an €8bn NPL clean-up. Despite the share price initially opening some -6% lower, it rallied back over the course of the day and closed up nearly +16%. That helped the sector surge higher with the FTSE Italia All-Share Banks Index closing up +5.83% which puts it about +30% above the intraday lows at the end of November. Yesterday’s move is in the context of a +2.49% bounce for the wider FTSE MIB and a +1.06% gain for the Stoxx 600. Credit indices in Europe were also tighter although financials didn’t particularly outperform. The iTraxx Main and Crossover indices finished 1bp and 7bps tighter respectively while Senior Fins and Sub Fins were 1bp and 3bps tighter respectively. The Italian banks were unsurprisingly at the front of the pack though with the average sub-spread of the 4 banks 11bps tighter. In rates BTP’s were also the big outperformer with yields -12.1bps lower at 1.870% versus -7bps for the rest of the periphery and -4.0bps for Bunds. It’s worth also noting the new Italy PM candidate, Gentiloni, comfortably won the first of two confidence votes from Italian Parliament yesterday. The Senate vote is this afternoon.

Meanwhile, it was back to business as usual for US equity markets yesterday afternoon where we saw the Dow (+0.58%) come within 100pts of the 20,000 level and the S&P 500 (+0.65%) record a fresh new record high. It’s impressive to note now that since Trump was confirmed the election winner, on the 24 trading days the S&P 500 has risen on 16 of those days has returned +6.18%. 10y Treasury yields hovering just shy of 2.5% (closing at 2.472% and little changed last night) failing to dampen spirits while commodity markets were mixed. WTI rose +0.28% and was up for the fourth session in a row while Gold (-0.32%) edged a bit lower ahead of the Fed.

Refreshing our screens this morning it’s been a fairly subdued session for Asia equity markets. That said most bourses are currently in positive territory including the Nikkei (+0.13%), Hang Seng (+0.51%), Shanghai Comp (+0.06%) and ASX (+0.69%). Only the Kospi (-0.05%) is in the red. There’s been a bit of action in JGB’s though after the BoJ offered to buy more longer-dated debt at today’s reverse auction. The Bank offered to buy 200bn Yen of debt due in 10-25 years which is up from 190bn previously and also 120bn Yen of bonds maturing in more than 25 years, versus 110bn Yen previously. The >25y buyback also drew 3.06x of interest, which is up from 2.39x last week. The JGB curve has bull flattened as a result. 2y yields are down 0.6bps at -0.203% while 10y yields are down -2.0bps to 0.050% having crept up as high as 0.096% just yesterday and the highest since February. 30y yields are down 3.4bps at 0.761%.

Meanwhile the Q4 Tankan survey was also out in Japan this morning. The survey revealed improvement for large manufacturing companies (to +10 from +6) while non-manufacturing companies were stable at +18. Meanwhile there was some modest improvement in the data for both manufacturing and non-manufacturing small companies.

Moving on and wrapping up the dataflow yesterday. In the US the NFIB small business optimism reading in November was reported as rising 3.5pts to 98.4 (vs. 96.7 expected). That post-election reading is in fact the highest reading since December 2014 with firms reported as being significantly more optimistic about the outlook for sales and also plans to hire. The other data in the US was the import price index reading for November (-0.3% mom vs. -0.4% expected) which was clearly weighed down by the strengthening US Dollar over the month.

Meanwhile the latest inflation data in the UK was out yesterday. Headline CPI printed bang in line at +0.2% mom for November, helping to raise the YoY rate to +1.2% from +0.9%. The core also rose to +1.4% yoy from +1.2%. Yesterday’s data means that headline CPI is in fact now running at the highest level since October 2014. Elsewhere, there were no surprises in the final revisions to the inflation data in Germany where CPI was confirmed as rising +0.1% mom and +0.8% yoy in November. There was some upside surprise from the latest ZEW survey however. The current situations index was reported as rising to 63.5 this month from 58.8 and to the highest level since September last year. Interestingly the expectations component held relatively stable however.

Looking at today’s calendar, this morning in Europe we’re kicking off in France where the final November CPI revisions will be made. Shortly after the focus turns to the UK where we’ll get the October and November labour market data. Industrial production data for the Euro area will also be released. It’s a packed afternoon for data in the US meanwhile. The early focus will be on the November retail sales figures. Market expectations are running at +0.3% mom for the headline and +0.4% for the core. The control group component is expected to come in at +0.3%. Also released today is the November PPI report along with last month’s industrial and manufacturing production prints (both expected to decline modestly). Business inventories data for the month of October will also be out. All that comes before the aforementioned main event this evening (7pm GMT) with the conclusion of the FOMC meeting. As a reminder, Fed Chair Yellen will host a press conference shortly after.

Having seen 10Y JGB yields spike to 10bps (highest since Feb), The Bank of Japan has decided enough is enough and intervened to bring yields back to the stable 0.00% level they decree as fair. The entire Japanese curve is bull-flattening as the long-end is also rallying after Kuroda and his cronies up their purchases to 200 billion yen, from 190 billion previously. All else equal, this will prompt more demand for US paper from Japanese sources.

10Y Yields had risen to their highest since Kuroda unleashed NIRP.

And so it was time to step in

And the 30Y rallying even more

As Bloomberg’s Mark Cranfield noted, The Bank of Japan is back in the JGB market. Yields sliding across the longer end of the bond curve as the BOJ buys super longs. If the Fed does a dovish hike later today, that could be the end of rising yields for this year.

This move also follows Jeff Gundlach’s earlier bond bull case, noting that he’s increasing duration and investor fear of bonds seems to be getting overdone.

Reading between the lines, Janet Yellen squirmed her way through question after question focused on the effect of Trump’s potential fiscal stimulus plan without a definitive answer except to say that a “fiscal boost not obviously needed to get back to full employment” warning that “policymakers must take GDP-to-Debt ratio into account”, and questioned whether a tax reduction plan would improve the economy or productivity at all.

Question from CNBC: In recent testimony your advice was for fiscal authorities to increase productive capacity of the economy. Do individual and business tax cuts increase the productive capacity of the economy? And how would the fed’s reaction be different to fiscal policies that increase the productive capacity of the economy and those that don’t?

 

Yellen: So, the statement that I made that it would be useful to increase the productive capacity of the economy reflects my concern that productivity growth has been very low. It is the ultimate determination of the evolution of living standards. Policies that would improve productivity growth would include policy changes that enhance education, training, workforce development, policies that spur either private or public investment to enhance the quality of capital, in the United States, that workers have to have to work with, and policies that spur innovation or competition or the formation of new firms. So tax policies can have that effect. It really depends on the specifics. I don’t think there is anything that I could say in general about what tax policy would do, but and I really can’t tell you what the fed’s response would be to any policy changes that are put into effect. I wouldn’t want to speculate until I were more certain of the details and how they would affect the likely course of the economy.

 

Follow up from CNBC: If there was a rush of fiscal policy, that did not increase the productive capacity of the economy, would that mean the Federal Reserve would have to move more quickly with raising rates?

 

Yellen: It is something I can’t generalize about, because while it would be desirable to have tax policies that do increase the productive capacity of the economy, an increase in the pace of productivity change is one of the factors that does affect the economy’s neutral rate, a boost to productivity could spur investment. As we have been saying, we estimate that the value of the neutral federal funds rate is quite low, and one of the reasons for that is slow productivity growth. So it’s very hard to generalize about it, because it could affect that neutral rate.

 

*  *  *

 

Question from the Washington Post: I’m curious, you and your predecessor had both at times called for more fiscal stimulus, to help with the outlook, the growth outlook. I’m wondering how much do you judge the economy has capacity for fiscal stimulus right now? It’s a version of Steve’s question but I think we are trying to get at, how much can happen before we run the risk of overheating?

 

Yellen: Well, I believe my predecessor and I called for fiscal stimulus when the unemployment rate was substantially higher than it is now. So with a 4.6 percent unemployment, and a solid labor market, there may be some additional slack in labor markets, but I would judge that the degree of slack has diminished. So I would say at this point that fiscal policy is not obviously needed to provide stimulus to help us get back to full employment. But nevertheless, let me be careful that I am not trying to provide advice to the new administration or to Congress as to what is the appropriate stance of policy. There are many considerations that Congress needs to take account of, and many bases for justifying changing fiscal policy. I’ve continued to highlight the importance of spurring productivity growth, that I think that would be something that is beneficial for the economy. Of course, it’s also important for congress to take account of the fact that, as our population ages, that the debt to GDP ratio is projected to rise, and that needs to continue to be taken into account. So there are many factors that I think should enter into such decisions.

And it appears to have taken the shine off of stocks…